Question

Assume the following economy:

Y1 = $200 (billion)

G = $ 60b

T = 0.4Y.

Yf = potential GDP = $320b

Using the above information answer the following questions:

1. does the budget balance have a cyclical behavior? if it does, is the budget balance procyclical or countercyclical?
2. would our economy have a structural balance problem? why or why not ? explain your answer

Answer 1

a)

The government budget balance is the difference between its tax revenue and expenditure. In this case, the budget balance is

Therefore, if the output increases, the budget balance improves, and vice versa. Therefore, the budget balance changes with output and hence has cyclical behavior. As the budget balance changes positively with the output it is procyclical.

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b)

The structural balance problem occurs if the economy has a negative budget balance or budget deficit at full employment. The budget balance at full employment is:

b

Then there is no problem of structural balance in this economy.